Sell Fannie and Freddie, don’t kill them

It’s time for the U.S. government to sell its ownership stake in Fannie Mae and Freddie Mac, the two giant mortgage funders, and let them sink or swim by themselves.

Bailed out by U.S. taxpayers six years ago, Fannie and Freddie are now spruced up, profitable and well-managed. Together, they will earn about $20 billion in profits this year. That’s more than General Electric.

On Aug. 7, the two mortgage giants announced they will pay another $5.6 billion — all of their second-quarter profits — to U.S. Treasury. That brings total bailout repayments for Fannie to $130 billion, or $14 billion more than it received in bailout money. Freddie has paid the Treasury $88 billion, or $17 billion more than it received.

In all, the taxpayers have achieved a return of 17 percent on their investment six years ago, and the U.S. government still owns 80 percent of both companies. Meanwhile, the Third Amendment, tacked onto the original 2008 bailout agreement in 2012, allows the government to “sweep” all of Fannie’s and Freddie’s profits into the Treasury’s coffers every three months.

The Third Amendment may well be an illegal taking by the feds. It’s being challenged now in the courts. However, the irony is that this perpetual conservatorship may be costing the Treasury money at the precise time that the federal deficit has been running at near-record levels.

Here’s why: Right now, Fannie Mae and Freddie Mac are highly profitable and, in the open market, would be worth hundreds of billions of dollars. Although many in Treasury considered the common stock of the mortgage funders worthless in the depths of the crisis, the government’s stake now represents the largest commitment fee in financial history.

What can the government do with this ownership stake? Convert it to cash. Private investors want to restructure Fannie and Freddie, and have already plowed huge sums into the firms. If restructured, Fannie and Freddie could be relisted on the New York Stock Exchange, and Treasury’s shares sold over time to public investors. The government would get out of a business it shouldn’t be in. The current ward-of-the-state condition is unsustainable.

If Fannie and Freddie earn a combined $20 billion annually (a conservative estimate), then, at a modest price-to-earning ratio of 13 (compared with an average of 15 for the three largest U.S. banks), the market capitalization of the two would be $260 billion, and the 80 percent stake owned by the government would be worth $208 billion. Add that to the $218 billion Fannie and Freddie have already paid the Treasury, and the total take is $426 billion — for a profit of 128 percent.

Think of the uses for that $208 billion in gains. Here are two good options:

First, the money could go to Treasury for deficit reduction. The budget deficit for fiscal 2014 is projected at $492 billion. The Fannie-Freddie gains would wipe out about two-fifths of it.

Second, Congress could move all or part of the proceeds into an affordable-housing trust that could fund mortgage relief for Americans who have lost jobs and subsidize affordable rental housing. To make the fund attractive to conservatives, there would be a ban on government requirements that Fannie and Freddie themselves fund or subsidize risky lending to low-income borrowers — the problem that got the two institutions into trouble in the first place.

Of course, there is a third choice: Throw all this value away. Who would do that? Right now, the legislation authored by Democratic Sen. Tim Johnson of South Dakota and Republican Sen. Mike Crapo of Idaho that is pending in Congress liquidates Fannie and Freddie and destroys the going-concern value while at the same time setting up the mortgage providers to be as politically bullied in their business decisions as they were in the past.

The stated reason for liquidating Fannie and Freddie is that they were flawed. No doubt. So were AIG and Citicorp, though, both of which are back on their feet as private companies. We fix flawed but valuable institutions in the United States; we don’t destroy them.

The reforms needed at Fannie and Freddie are straightforward: retain earnings and boost capital, focus on the guarantee business and shut the riskier portfolio business, end the federal subsidies and political requirements, and encourage more competition. This is a set of changes easy to achieve within the context of private ownership — a far better result than any of the current proposals in Congress.

American taxpayers stepped up in the financial crisis, and they deserve to double their money. For that to happen, the government needs to act responsibly and sell Fannie and Freddie to private owners — not throw a $200 billion asset away.